Arbeitspapier

The convergence of international interest rates prior to Monetary Union

The process of international interest rate convergence for arbitrary terms (represented by the term structure of interest rate differentials) is derived in a model of a small open economy which faces a purely time-contingent exchange rate regime switch from flexible to fixed rates. Special attention is paid to a situation in which financial markets deem a delay in the regime switch beyond the publicly announced fixing date possible. The closed-form solution of the term structure allows us to analyze the volatility of interest rate differentials thus providing a useful tool for interest-rate-sensitive security valuation and other risk management applications. Furthermore, the model demonstrates that the economy under consideration has to pay for the exchange rate stabilization triggered by the mere announcement of future regime switching by a higher uncertainty in the evolution of domestic interest rates.

Language
Englisch

Bibliographic citation
Series: HWWA Discussion Paper ; No. 127

Classification
Wirtschaft
Interest Rates: Determination, Term Structure, and Effects
International Monetary Arrangements and Institutions
Foreign Exchange
Subject
Exchange rate regime switches
interest rates
term structure
stochastic processes
uncertainty
Zins
Zinsdifferenz
Entwicklungskonvergenz
Wechselkurspolitik
Währungsunion
Monetäre Wechselkurstheorie
Kleines-offenes-Land
Stochastischer Prozeß
Theorie
regime switching

Event
Geistige Schöpfung
(who)
Wilfling, Bernd
Event
Veröffentlichung
(who)
Hamburg Institute of International Economics (HWWA)
(where)
Hamburg
(when)
2001

Handle
Last update
10.03.2025, 11:41 AM CET

Data provider

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Object type

  • Arbeitspapier

Associated

  • Wilfling, Bernd
  • Hamburg Institute of International Economics (HWWA)

Time of origin

  • 2001

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